Things Not to Do When Trying to Get Out of Debt Quickly
- Author: Monica Jackson
- Posted: 2024-10-13
The personal finance experts tell you that getting out of debt is the best thing that you can do for your own financial situation. This is mostly true, but it comes with a caveat. People have been known to go to extremes to get out of debt. In the process, they open themselves up to the possibility of dumb mistakes that can make their financial situation even worse. Here are four costy errors that one makes when trying too hard to get themselves out of debt.
Taking Out a High-Interest Loan
Borrowing from one source to pay another makes practically zero sense. Many people are tempted to take out a payday loan or a high-interest rate personal loan in order to pay off another debt. This is merely using one source of credit to pay off another. Moreover, the high interest rate will leave you vulnerable to going into default on your new loan. Some debts are better to keep and pay off slowly because the alternative can be worse.
Another very bad source of cash to tap when trying to get out of debt is a credit card cash advance. This is essentially one step shy of a payday loan when it comes to interest rates. While the rates do not reach triple digits, you will find yourself paying roughly 25% for a credit card cash advance. These are very hard to pay off because credit card companies fix the rules to make these advances the last thing that gets paid off in your balance.
Paying Off Lower Interest Rate Loans First
People are taught to pay off student loan debts and to try to get ahead on these payments. If you have other debts, this is generally not a good idea. The rule of thumb is to focus on the highest interest rate debts first before trying to get ahead anyplace else. If you are laden with debt, make a list of all of the interest rates that you pay on your loans. If you are forced to prioritize between debts, always choose the highest interest rate ones first. These are the payments that will save you the most money every month by cutting the amount that you will need to pay in interest. This means that credit cards and personal loans with the highest rates should be the first debt payments that you should try to clear.
Paying Off Other Debts with Credit Cards
However, in the process, they might be tempted to charge their payments to their credit cards. Even if they are not getting ahead on payments, they may be using a credit card anyway to keep up with their obligations. For example, if you end up with a medical bill of several thousand dollars, your first thought may be to put the bill on your credit card to be figuratively done with it so the doctor's office does not send the collections company after you. Your best bet is to try to negotiate with the doctor's office to establish a payment plan over time. Putting the bill on your credit card just swaps out creditors. Now, the bank can and will come after you if you are not able to keep making payments on your credit cards. You may be in a better position to negotiate with a smaller creditor than you would with the credit card company.
Cashing Out of Your Retirement
Taking a loan against your retirement may be a viable strategy for getting out of debt. Cashing out of your retirement is not. The reason is because when you cash out of your retirement, you become subject to a number of things that you have to pay that reduces the amount of money that you receive. First, you will need to pay state and local taxes on the money that you have received unless you are taking from a Roth IRA. Second, taking money from your retirement will also lead to early withdrawals penalties. With taxes and the penalty, you will be lucky to see 60 cents on the dollar when you cash out of your retirement. In the meantime, it goes without saying that you will be setting your retirement plan back for years for every withdrawal that you make. You also need to consider the future rather than just the immediate worry about getting out of debt quickly.
